Taxation on U.S. Savings Bonds
TaxesTaxation on U.S. Savings Bonds
A client needs help with complicated IRS rules
Scenario #1 - A question from Grace
I have a number of mature EE savings bonds that I inherited from my mother. I have been redeeming a few every year to avoid paying a large amount of taxes at one time. What should I do if I want to redeem them all now?
What are Savings Bonds?
Savings bonds were supposed to be a simple, secure investment, but 30-plus years later, it probably doesn’t seem that way. Series EE Savings Bonds bonds (and other series before them E bonds before them) were popular gifts for birthdays and college savings, but they are not so common today given all the other investment and savings choices available.
Fortunately, you have the bonds and a clear designation of ownership. Too many people (myself included) have forgotten about paper savings bonds, and then either don’t pass them along to their heirs or don’t provide instructions for them if they are found stashed in a box somewhere. In those cases, the bonds end up as unclaimed funds, and you have to go through the steps to find them and claim them as a legitimate heir, which might be cumbersome. The Treasury Department has an online tool for this, appropriately named Treasury Hunt.
When are taxes due?
Here’s the catch, the tax on E/EE bonds is due when you cash them or in the year they reach their full maturity (regardless of whether you hold them longer than that). So if you have E/EE bonds of your mother’s that are past their full 30-year maturity date, you should have already paid the tax on them. Since EE bonds have been issued since 1980, and other savings bonds have been issued since the 1930s, it’s entirely possible that you have some that are that old. They also stop earning interest after that 30-year mark, so there’s no growth incentive for holding onto them.
Another catch, savings bonds don’t get a step-up in basis at death the way stocks or other investments do. That means you have to pay tax on the full amount of interest due on the bonds as the inheritor.
Penalties on old savings bonds
Cashing them all in now and dealing with the tax is probably a good way to go. Let’s start with just ones that were issued less than 30 years ago. The interest would hit your 2024 taxes, which would have to be filed by April of 2025.
If cashing them out now generates interest income that is a significant amount above your normal tax burden, you should make an estimated tax payment at the time of the transaction. The easiest way to do this is online via IRS.gov/payments.
You can determine how much interest you have earned on a savings bond by using Treasury’s online calculator. The Internal Revenue Service notes in its instructions for estate administrators that you may be able to deduct some of this interest income if you paid estate taxes on your mother’s estate.
If you have bonds that have already matured, work with a tax professional to figure out the best way forward. If the savings bonds were issued more than 30 years ago there could be a sizable amount of interest earned and thus taxes due and the IRS may not look the other way if you try to stretch out the tax burden. Fixing a problem like this will involve calculating the interest amount owed and then any IRS penalty, and it may involve filing amended returns for the years where the bonds came to maturity. Hopefully, you kept good records of the transactions, but if not, be sure to note all the dates and amounts going forward.
A twist on Grace's original question - another scenario to consider
My mother passed away earlier this year, I am the executor of her estate, and my mother owned a number of mature and immature savings bonds, and my sister and will inherit the bonds.
You have options for taxation
In this situation you’re going to want to work with a tax professional to figure out the best way forward. You have a few options though. 1) You could choose to include all interest earned on her savings bonds before her death on her final tax return 2) Your mother’s estate could choose to pay the tax on all the interest earned on the bonds before her death 3) the bonds could be passed on to you and your sister and then you each would be responsible for any tax owed on the interest from bonds. For example, your mother’s income tax rate may be lower than yours so it may be advantageous to have the interest reported on your mother’s final tax return rather than you and your sister having to pay the tax on your personal tax returns.
Conclusion
The taxation of U.S Savings Bonds is surprisingly complex for an investment that was supposed to be simple. If you find yourself in any of these situations seek out a knowledgeable professional who can guide you through the process and help you make the best decisions for you.